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Supreme Court Should Scale Back Securities Class Actions

Opinion

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assumed there was a lot of risk in doing so.  Furthermore, it is also ridiculous to assume that something up that much over such a short period of time is priced efficiently.  This law firm is doing a disservice because it is wasting the company’s time and money, and putting the interests of short-term traders ahead of long-term investors.

Why These Lawsuits Can be Bad for the Capital Markets

Frivolous lawsuits like this are a big deal because they can hurt not just the individual companies involved, but also the capital markets as a whole because they make them less appealing.  A sign of that is the paucity of public companies we have in this country these days.  While you might be marveling at the red hot IPO market lately, recent statistics from WSJ tell a different story and show how we are still barely playing catch up.  Believe it or not, we started last year with the smallest number of publicly traded companies going back to 1991.  In fact, the problem is so bad that there are now only 3,667 companies in the Russell 5000 index because there are no longer 5,000 relevant companies to be found.  This is not a good thing for our economy.

In short, when you make it so burdensome to be a public company, few people want to go that route anymore.  Furthermore, many of the ones that do go public usually wait until they have matured, and arrive on the public markets at the last minute possible so that none of this nonsense disrupts their growth in the important early years.  Biotech is a little different, because it is so capital intensive and leans on public markets heavily, but this is a big problem especially in other industries.  While I don’t blame the lawsuits for all of it, they are definitely a contributing factor.  We are way too focused as a financial community on the short-term and playing gotcha, which is not a good thing for fostering long-term growth and innovation.

So What Happens if the Supreme Court Strikes Down Fraud-On-The Market?

The question now is how can we move forward in a better way?  You can bet that if the Supreme Court rules decisively against fraud-on-the-market, it is unlikely that this story, and the lawsuits, will just go away forever (more on that later).  However, I’d argue that such a scenario wouldn’t even necessarily be all that bad.

First of all, I’m not sure investors need these lawsuits to do our bidding for us.  As far as I’m concerned, we are more than capable of standing up for ourselves through shareholder activism, which is at an all-time high in effectiveness.  These days if there is a problem with management, shareholders (and journalists) are able to sniff it out fast, mobilize quickly, and act as a bigger check and balance than we historically could have ever dreamed of.  There are various reasons for this, but you can thank technology and social media for some of it.  Even Carl Icahn, the billionaire investor who has been challenging management teams since the ‘80s, has made social media a big component of his activism campaigns lately.

Second, I’d argue that these lawsuits don’t act as a deterrent, so what is the point of all the time and money put into them?  It would be different if they were more directly helping investors, but most executives tell me they simply view this as the cost of doing business, and investors rarely end up gaining anything meaningful when the lawsuits are settled.  Furthermore, in major cases, the ones that should set an example and serve as a deterrent to other bad actors, the SEC and Department of Justice can and do get involved.  Comparatively speaking, private class-action lawsuits are meaningless, so I wouldn’t be concerned as an investor if they were scrapped altogether.

What is more likely in this case if the Supreme Court does rule against fraud-on-the-market completely is that Congress will probably step in afterwards and write something directly into law.  I would be all for that because the process needs to be reinvented, and it is a topic that deserves much more thought and open debate.  I would recommend at a minimum that any such law include provisions that give added deference to long-term investing. I’d also like to see some kind of additional deterrents to filing frivolous cases, such as a rule that requires plaintiff law firms to pay the opponent’s fees if their case is dismissed. Judges and mediators could also be given much more leniency to decide which cases might actually be in the overall market’s best interest.  Any of those things could allow the legitimate cases to still go forward while cutting down on the frivolous ones.

It is technically possible that the Supreme Court will find some middle ground too, such as requiring future cases to prove early on how management actions did specifically cause a stock move, but I would strongly recommend starting over from scratch.  The system is clearly broken, let’s build it again from the ground up for the benefit of companies and investors.

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4 responses to “Supreme Court Should Scale Back Securities Class Actions”

  1. micro kid says:

    Very good article! Hopefully sanity will prevail over the current insanity. I really wonder, if some of these lawsuits and threats of lawsuits are designed to disrupt the price. Most of these companies have E&O insurance, so the law suits will have minimal effect to operation. When companies have to search for a lead plantiff, there is something wrong with the system.

  2. Ramsis423 says:

    Unfortunately the cases continue.. I’m tired of seeing articles in my news feed about Levi and Korsinsky attempting class actions against good companies.. especially pharmas trying to develope life saving drugs (Vertex being the most recent I believe).

  3. binthere222 says:

    It is greenmail plain and simple, but even worse if the lawfirm holds, or represents a person who holds, a short position in the stock.
    In any case simply re-publicizing that they are LAUNCHING an investigation is a misrepresentation. Unless of course they have closed a previous investigation.
    Beside any complaints to the NY Bar ethics committee, A referendum is in order for the ballot in NY state. Simply stated and vetted for if it would stand up to appeal. Change it to an opt out form of class action and go back to “you sue, you lose, you pay”.